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A 3 Fund Portfolio is a type of lazy portfolio that contains only three investments.
It’s called “lazy” because of how simple it is to set up and manage. Though, for once in your life, investing with a lazy portfolio is a situation where being lazy can pay off.
A 3 Fund Portfolio historically has a higher probability of providing superior growth and returns compared to actively managed portfolios. This is because actively managed mutual funds have a tendency to underperform the market, while a lazy portfolio simply attempts to match market returns while keeping costs low.
And as we know, a basic index investing approach that matches the market performance through a diversified portfolio is a winning strategy over the long term.
The added beauty of the 3 Fund Portfolio is its simplicity – it’s easy to set up and manage. Anyone can do it on their own.
Disclaimer: Just Start Investing is not a certified financial advisor. This informational article on the 3 Fund Portfolio: The Lazy Way to Invest is designed to be educational, but not professional advice.
What is a 3 Fund Portfolio?
A 3 Fund Portfolio is exactly what it sounds like: an investment portfolio made up of three investment vehicles or funds.
Specifically, the investment vehicles are:
- US Equity Fund
- International Equity Fund
- Bond Fund
The 3 Fund Portfolio was popularized by Bogleheads – loyal John (Jack) Bogle followers.
Jack Bogle is the founder of Vanguard and was a pioneer for index investors who valued low-cost options. Before Bogle, it was nearly impossible for a small-time investor to attain a diversified portfolio without paying large management fees.
The 3 Fund Strategy is actually so popular among index investors that a Boglehead (Taylor Larimore) even wrote a book on it.
Types of 3 Fund Portfolios: Choosing your Asset Allocation
The most effort you need to exert when setting up this lazy portfolio is deciding the level of capital to allocate to each of the asset classes (or funds).
This topic is hotly debated, but there are a few basic options to be aware of. Obviously, you are not limited to the three examples below, but they are a good start to building a balanced portfolio.
Option 1: Equal Weight Asset Allocation
The first and simplest breakdown would be to assign an equal amount of capital to each of the 3 funds in the portfolio.
Option 2: 80/20 Asset Allocation
Another popular option is to assign 80% of your funds to a stock market fund and the remaining 20% to a bond market fund.
The assumed split between US and international stocks here is 75% / 25%.
Option 3: 60/40 Asset Allocation
Last, the most conservative of the three examples is to assign only 60% of your funds to stocks and the remaining 40% to bonds.
Again, the assumed split between US and international stocks here is 75% / 25%.
Remember, the above are just examples to help you visualize how you could build a 3 fund portfolio.
While these examples are helpful, in reality, there are two really important things to decide on when choosing your own custom asset class allocation:
- Allocation of stocks vs bonds
- Allocation of US vs international equity
We’ll dive into both below.
Allocation of Stocks vs Bonds
There are two popular views on how much of your portfolio to invest in stocks vs bonds.
One view is that the percentage of your portfolio that you invest in bonds should match your age.
So, if you are 20, your portfolio should consist of 80% equities and 20% bonds. And if you are 60, your portfolio should be 40% equities and 60% bonds.
This is a good rule of thumb, but it is not necessarily the best approach.
Recently, many experts have recommended that you stay more aggressively invested in stocks later in your life. Warren Buffet has even suggested investing 90% in stocks (and only 10% in bonds) into retirement.
At the end of the day, you have to decide what risk profile is right for you based on many factors, including your income, age, and how long you have until your target retirement date.
Allocation of US vs International Equity
Are 75% in US equities and 25% in international equities the right split?
That’s a difficult question to answer. There are two popular opinions to understand on this matter as well.
One opinion is that even though US Equities are labeled as “US”, they still have a global element to them. Most US companies have parts of their businesses that operate and make money overseas. So, by investing in US companies, you are also partially investing in international business and already diversified.
Naturally, supporters of this view believe you need a smaller percentage of money invested in an international stock fund (including emerging markets). Say, between 0-20%.
On the other hand, you have experts who believe you should market weight your stock portfolio to match the larger global economy. This would mean investing as much as 40% of your equity portfolio in a total international index fund because international companies make up around 40% of the global economy.
Vanguard recommends this 40% split, as they argue it provides proper diversification.
Likely, somewhere between 0-40% is the right allocation. There is no consensus here, so do a little homework and decide what is right for you. And if you can’t decide, you could take the same approach as Larimore and meet in the middle at 20%.
Benefits of a 3 Fund Portfolio
There are countless benefits associated with a simple 3 Fund Portfolio. But below are the three biggest benefits that you need to be aware of.
The great thing about a mutual fund is that you can own hundreds, if not thousands, of individual stocks or bonds with only one investment.
With a 3 Fund Portfolio, you get the simplicity of only having to manage three investments while also getting the benefit of effectively owning hundreds of investments.
Owning a simple portfolio makes it easier to rebalance, monitor, and keep track of your investments. You don’t have to constantly check-in to make sure you are diversified. It also eliminates the need for you to pay someone to manage your investments for you, which is a huge cost you should avoid if you can.
Speaking of costs…
The 3 Fund Portfolio also has low fees and expenses, when done right.
Most index funds and Exchange Traded Funds (ETFs) have low expense ratios of around 0.02%-0.10% or less. This is a great value compared to expensive mutual funds (or target retirement funds) that might have a 0.25%-0.50% expense ratio. Or to a fund manager who often charges 1% or higher.
That’s high-way robbery. Save your money and build your net worth, not theirs!
Plus, when you only need to buy three funds, it’s a lot easier to shop around and ensure you are getting the best deal on the three you choose. Rather than trying to select 10 or 20 funds that fit the low-cost profile, you just need a couple.
Third on the list of benefits is the diversification that a 3 Fund Portfolio provides.
Yes, it’s only three funds. And yes, it was super easy to set up. But, as mentioned before, since your three funds are comprised of hundreds or thousands of stocks and bonds, you are easily and quickly diversified.
Diversification lowers your risk and helps provide steady, long term returns year after year (on pace with how the overall market performs).
Last but not least, a 3 fund portfolio will work to simplify your taxes as well.
I won’t go into too many details here, but the main drivers of tax efficiency are twofold.
Low In-Fund Turnover: Index Funds have low turnover, which means you pay fewer taxes on capital gains every year than with mutual funds.
Low Out-of-Fund Turnover: Compared to stocks, where you may be forced to sell your winners to rebalance at the end of the year, a portfolio of 3 funds eliminates most of that need. Again, helping you to avoid capital gains taxes.
How to Build a 3 Fund Portfolio
Building a 3 Fund Portfolio is easy – especially when using a broker like Charles Schwab.
Schwab is a great online broker for a few reasons, but mainly because of its low fees, the wide selection of different funds, and easy to use interface. Plus, you can trade their funds for free.funds
Of course, Vanguard is also a leader in this space. So we’ll walk through a couple of example portfolios below to help you visualize how you can build your own 3 Fund Portfolio.
Last, a 3 Fund Portfolio can be built in various types of investment accounts: taxable accounts and tax-advantaged accounts like a 401(k) or Roth IRA. Here’s how you could do it:
The following funds could make up a Schwab 3 Fund Portfolio:
- SWTSX – Schwab Total Stock Market Index Fund (0.03% expense ratio)
- SWISX – Schwab International Index Fund (0.06% expense ratio)
- SWAGX – Schwab U.S. Aggregate Bond Index Fund (0.04% expense ratio)
Alternatively, Schwab also has some ETFs that have similar expense ratios as the above funds. You could also consider:
- SCHB – Schwab U.S. Broad Market ETF (0.03% expense ratio)
- SCHF – Schwab International Equity ETF (0.06% expense ratio)
- SCHZ – Schwab U.S. Aggregate Bond ETF (0.04% expense ratio)
Last to call out on Schwab: they also have an S&P 500 Index Fund (SWPPX) with a 0.02% expense ratio. That’s great value for a stock fund but has slightly less diversification than some of the total market index and broad market index funds above.
The following funds from the pioneer of index investing could be used to build a 3 Fund Portfolio using Vanguard:
- VTSAX – Vanguard Total Stock Market Index Fund (0.04% expense ratio)
- VTIAX – Vanguard Total International Stock Index Fund (0.11% expense ratio)
- VBTLX – Vanguard Total Bond Market Fund (0.05% expense ratio)
Vanguard, like Schwab, has a good selection of ETFs as well. You could also consider:
- VTI – Vanguard Total Stock Market ETF (0.04% expense ratio)
- VXUS – Vanguard Total International Stock ETF (0.09% expense ratio)
- BND – Vanguard Total Bond Market ETF (0.05% expense ratio)
As you can see, Charles Schwab generally has lower expense ratios across the board.
However, you can’t go wrong with either option. Especially considering that Vanguard was the pioneer of index investing and still has rock bottom fees compared to other investment brokers.
Another Option: The Robo-Advisor Betterment
Another investment broker that can create a lazy portfolio is Betterment.
You cannot build a portfolio of just three funds with Betterment (to my knowledge). Though, you can take a really hands-off approach to build a low-cost portfolio.
It will cost slightly more because Betterment charges a management fee, but it offers a clear service for that fee (including automatic tax-loss harvesting).
You can get my full guide on how to start investing with Betterment here.
3 Fund Portfolios – In Summary
One last great thing to note is the flexibility that comes with lazy portfolios. You can customize this strategy to meet your needs by going to a 4 or 5 fund portfolio, or a 2 fund portfolio (if you want to eliminate international stock market funds all together).
Just remember the core benefits of a 3 Fund Portfolio – a simple, diversified, and low-cost portfolio. Make sure you aren’t straying too far away for it’s intended purpose.